August Monthly Market Update
As at end of August 2022
Echoes of Volcker slam sentiment
Global equities started the month off on a strong note, continuing to make gains on increasing optimism that inflation may have finally peaked and that the Federal Reserve (Fed) would soon pivot away from aggressive monetary policy tightening. However, at the central bank symposium held at Jackson Hole, Fed Chair Jerome Powell reaffirmed that achieving price stability and an inflation target of 2% remain the primary focus. Powell also acknowledged the prospect of a prolonged period of restrictive policy and associated pain for households and businesses as a lesser evil to the alternative of failing to control inflation. Powell’s message was loud and clear, and even made references to Paul Volcker – a former Fed Chair who is widely credited with successfully containing high inflation in the early 1980s through highly restrictive policy which pushed the US economy into a severe recession. The hawkish messaging caused equity markets to sell-off sharply, seeing the MSCI World (NZD) Index giving up its earlier gains to close -2% for the month.
Despite the strong rebound seen in equity markets since the June lows, the backdrop for investors continues to remain uncertain and fragile. While corporate earnings for the 2Q22 period were broadly positive and exceeded analyst estimates, there was a deterioration in quality and growth within the results. For the S&P 500 Index in aggregate, reported revenue was above expectations, primarily reflecting inflationary pass-through, whereas earnings were relatively weak on rising wage costs and supply chain constraints. At the individual sector level however, it is evident that US corporates in most industries are not in the best shape. Stripping out the Energy sector, which has benefited enormously from this year’s rally in oil prices, earnings for the rest of the market actually contracted, driven primarily by the Consumer Discretionary, Financials, and Communications sectors. Looking ahead, of those companies that issued earnings guidance for their current fiscal year, 55% revised their guidance downwards. This has finally resulted in analysts revising down their future earnings expectations, making equity valuations less attractive.
NEW ZEALAND EQUITIES
Versions of mean reversion
August reporting season was a mixed bag with positive surprises for revenues and to a lesser extent earnings, while profit and dividend outlooks were more circumspect. Cost inflation, especially on the labour front continues to be a running theme. Lags and limits on passing these through via price increases has also contributed to margins being squeezed for some companies. Against this backdrop, the benchmark S&P/NZX50 Index eked out a 0.9% return for the month bringing the year to date return to -11%.Infant formula brand a2 Milk was the Index’s top performer, returning 24.8% after its result beat analyst expectations. The relief rally was underpinned by indications the worst may have passed after a challenging couple of years. Elsewhere, two other strong performers were Air New Zealand and Tourism Holdings, returning 11.5% and 10.6% respectively on optimism that tourism and travel volumes make a stronger comeback. Asset-gatherer Infratil was another notable performer, returning 8.0% on the back of a substantial upward revaluation of its US renewable energy affiliate.
The worst performer in the index was biotech Pacific Edge, which returned -42.3% after emerging from a trading halt following speculation about reimbursement changes for its Cxbladder cancer biomarker tests in the US. In the accompanying disclosure, the company took pains to mollify concerns but confirmed the proposed changes would have a material impact on revenue if implemented. Other notable underperformers were Restaurant Brands and Fisher & Paykel Healthcare, which returned -15.5% and -7.3% respectively. Restaurant brands warned full-year profit could fall almost 40% as inflation and covid absenteeism continue to weigh on its franchises; whereas Fisher & Paykel indicated a sharper than expected reversion of respiratory device revenues back to pre-pandemic levels in its first half 2023 guidance.
In the aftermath of a highly anticipated corporate reporting season, the S&P/ASX 200 Index closed the month with a 1.2% return. Fortunes diverged markedly between sectors, with Energy and Materials returning 7.8% and 4.4% respectively, whilst Property fared worst with a -3.5% return. Whilst major surprises versus market expectations were fairly limited, uncertainty was a prominent theme, with outlook statements broadly cautionary about the year ahead amidst poor demand visibility and labour availability challenges.
Reenergised interest in materials required to support energy transition was the common thread behind the top three performers this month. Lithium hopeful Lake resources returned 44.4% despite no news since its quarterly report in late July, Copper miner Oz Minerals returned 36.8% after rebuffing an $8.3b takeover approach from BHP, and Lithium miner Pilbara returned 31.8% after it flipped from loss making to a $562m annual profit. Conversely, women’s fashion retailer City Chic was the worst performer, returning -29.1% after the combination of falling margins and a near doubling of inventory sparked fears of heavy discounting ahead into a weakening consumer environment overseas.
In contrast to unseasonably heavy rain and flooding on the East coast, macroeconomic data have been a scorcher. Annualised CPI inflation accelerated from 5.1% to 6.1%, unemployment fell to a 48-year low of 3.5%, and the May trade surplus came in over A$5b ahead of expectations. With the RBA still behind the curve at 1.35% after its second 0.50% hike in early July, more large hikes to rein in the economy are likely in coming months. Market-implied pricing currently anticipates a 3% cash rate by year end.
Talking the talk
Yields moved higher in August as investors priced in stronger commitment from central bankers in their efforts to tackle inflation. This led to negative returns for the month with the S&P/NZX Investment Grade Corporate Bond Index ending -1.7%, eroding the gains made in July. Credit spreads remained range bound for the month, resulting in little distinction between New Zealand and Australian corporate bond returns. Longer duration government bond indices underperformed on both sides of the ditch, absorbing much of the shift higher in yields and sustaining falls of around 3% apiece. In the wake of corporate reporting season on both sides of the Tasman, balance sheets remain in relatively healthy positions and management teams are displaying more confidence in re-establishing capital expenditure plans, albeit with a sharper focus on costs and returns as the cost of debt ratchets higher.
Australia’s hiking cycle was further advanced by the RBA raising rates as expected by 0.5% to 1.85%. Updated forecasts remain relatively dovish and contemplate cash rates peaking around 3% with GDP steadying to 1.8% in 2023. The RBNZ similarly hiked by 0.5% to lift the OCR to 3%, which also came as little surprise to the market. In contrast to the RBA’s more dovish estimates, the RBNZ marginally revised its OCR track to indicate a 4.1% peak by Q2 of 2023, with GDP growth expected to contract below 1% next year. Updated projections exhibit a steeper trajectory for unemployment in New Zealand, which is expected to rise to 5% compared to a more optimistic reading of 4% in Australia.
Jackson Hole, the Fed’s economic symposium known by its location in Wyoming, captivated the market’s attention in second half of the month. Chair Jerome Powell was resolute in his address by reaffirming the FOMC’s pledge to getting inflation back down to the 2% target. The hawkish address all but dashed market hopes for rate cuts in the first half of the New Year.